This post was written by Matthew D’Ascenzo.
Convertible, non-participating preferred stock has a senior liquidation preference pursuant to which the preferred shareholder receives back its invested money plus all accumulated, unpaid dividends before the common shareholders get paid. Unlike straight preferred stock, however, this type of preferred stock has the option of sharing in the appreciation in the value of the company by converting into common stock. Upon the sale of the company, the preferred shareholder can either (a) receive the senior liquidation preference or (b) convert to common stock and receive its share of the sales proceeds. The preferred shareholder can choose whichever option is more lucrative.
This type of preferred stock is commonly found in early-stage venture capital investments. Because of the speculative nature of these companies, an investor typically hopes for significant appreciation in the company’s value and is not relying on the stable, fixed-income aspects of preferred stock. This type of preferred stock also can be used in buyouts with a management rollover as an alternative to non-convertible, double-dip participating preferred stock.